CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

The capital market is the part of the financial system in which medium- and long-term funds move from those who have savings to those who need finance for productive investment. It is usually divided into two segments. The primary market, or new issues market, is where governments and companies raise fresh funds by issuing securities to the public or to selected investors. The secondary market is where securities that already exist are bought and sold among investors.

Because the market links savers to long-term investment, a long tradition in finance argues that capital market development supports economic growth. A liquid equity market lets savers sell their holdings quickly and cheaply, which makes them more willing to commit funds to projects that pay off only over many years. Firms in turn gain steady access to equity capital. Stock prices also carry information that helps investors allocate funds more efficiently, and a listed company is subject to closer scrutiny by shareholders. Through these channels, a well-functioning exchange is expected to raise the volume and quality of investment.

The empirical record, however, is far less settled than the theory. A central question is the direction of causality. Under the supply-leading hypothesis, deliberately building financial institutions and markets expands the supply of financial services and so drives growth (Adeyeye, 2015). Under the demand-following hypothesis, growth comes first: an expanding economy raises the demand for financial services, and financial markets develop in response. Chow et al. (2019) tested both explanations for developing countries, reflecting continuing uncertainty over which one applies.

Studies of Nigeria illustrate the divergence. Adeyeye (2015) examined 1981 to 2013 and found only weak support for the supply-leading view, concluding that demand-following dominated, although the results also indicated two-way causality between financial development and growth. Osamwonyi and Osaseri (2020), using quarterly data for 1995 to 2015, found no Granger causality in either direction between stock market development and economic growth in Nigeria. Broader work on the finance-growth relationship in sub-Saharan Africa likewise suggests that the strength and direction of the link depend on how financial development is measured and on country conditions (Aluko et al., 2020; Orekoya et al., 2021).

Most of this literature starts from the supply-leading assumption and asks whether capital market development raises growth. Comparatively few studies treat growth as the driving force and ask whether it explains the development of the capital market. This study addresses that gap by testing the demand-following argument for Nigeria, that is, whether growth in the Nigerian economy has promoted the development of its capital market. In effect, it is a test of reverse causation.

1.2 Statement of the Problem

The capital market is a principal channel for mobilising long-term funds for investment. The Nigerian capital market was established in 1961 to meet the long-term capital needs of the economy, and both the economy and the market have expanded over time. The problem this study addresses is how far the growth of the economy has shaped the development of the market.

An expanding economy is expected to produce a financial sector that pools domestic savings and directs them to productive uses. By contrast, a stagnant economy can hold back the development of the stock market and give rise to two problems: low capitalisation, which weakens the market's role in mobilising savings, and illiquidity, which weakens its role in supporting investment.

The capital market is the link between the financial sector and the real sector. It channels long-term savings, such as pension and insurance funds, into long-term investment, and it transfers purchasing power from surplus units to deficit units in return for greater purchasing power in future. It lets corporations finance real assets, relieves pressure on the banking system by matching long-term investment with long-term funds, widens ownership of productive assets among small savers, and encourages thrift, which supports the saving and investment ratios that industrialisation requires. In a weakly developed economy, however, limited size and activity may not be enough to sustain a growing stock market.

Evidence on the direction of the relationship remains mixed. Adeyeye (2015) points to demand-following behaviour in Nigeria, whereas Osamwonyi and Osaseri (2020) detect no causal link in either direction. These differences point to the need for further testing that is explicit about the direction of causation. Recent market data show why the question stays relevant: the Nigerian Exchange reported that turnover rose by 27 per cent in 2022, from N916 billion to N1.16 trillion, in a year when the economy and global markets were under strain (Nigerian Exchange Limited, 2023).

In this study, the capital market means the market for medium- and long-term financial instruments, mainly stocks and bonds with maturities above one year, together with the institutions, instruments and facilities that move savings into long-term investment. Economic growth means a sustained increase in an economy's capacity to produce real goods and services, usually measured by growth in real output or per capita income.

1.3 Objectives of the Study

The main objective is to determine the impact of economic growth on capital market development. The specific objectives are to:

1. examine the impact of economic growth on the market capitalisation ratio of the Nigerian Stock Exchange;
2. examine the impact of economic growth on the turnover ratio of the Nigerian Stock Exchange;
3. examine the impact of economic growth on the value traded ratio of the Nigerian Stock Exchange;
4. examine the impact of economic growth on the new issues ratio of the Nigerian Stock Exchange;
5. examine the impact of economic growth on the number of listings on the Nigerian Stock Exchange; and
6. examine the causal relationship between economic growth and the capital market development indicators in Nigeria.

1.4 Research Questions

In line with the objectives, the study asks:

1. To what extent does economic growth have a positive and significant impact on the market capitalisation ratio of the Nigerian Stock Exchange?
2. To what extent does economic growth have a positive and significant impact on the turnover ratio?
3. To what extent does economic growth have a positive and significant impact on the value traded ratio?
4. To what extent does economic growth have a positive and significant impact on new issues?
5. To what extent does economic growth have a positive and significant impact on the number of listings?
6. To what extent is there a causal relationship between economic growth and the market development indicators of the Nigerian Stock Exchange?

1.5 Research Hypotheses

The following null hypotheses are tested:

1. H01: Economic growth does not have a positive and significant impact on the market capitalisation ratio of the Nigerian Stock Exchange.
2. H02: Economic growth does not have a positive and significant impact on the turnover ratio of the Nigerian Stock Exchange.
3. H03: Economic growth does not have a positive and significant impact on the value traded ratio of the Nigerian Stock Exchange.
4. H04: Economic growth does not have a positive and significant impact on the new issues ratio of the Nigerian Stock Exchange.
5. H05: Economic growth does not have a positive and significant impact on the number of listings on the Nigerian Stock Exchange.
6. H06: There is no causal relationship between economic growth and the market development indicators of the Nigerian Stock Exchange.

1.6 Scope of the Study

The study tests reverse causation between capital market development and economic growth in Nigeria over the 15-year period from 1996 to 2010. It uses annual data on real economic growth and on four market indicators: market capitalisation, value of shares traded, total new issues and the number of securities listed. The data come from the Central Bank of Nigeria Statistical Bulletin, the Securities and Exchange Commission Statistical Bulletin and the Nigerian Stock Exchange Factbook.

The period begins just after a set of major reforms in 1995. The federal government repealed the Exchange Control Act of 1962 and the Nigerian Enterprises Promotion Decree of 1989, which had restricted foreign participation in the economy. It replaced them with the Foreign Exchange (Monitoring and Miscellaneous Provisions) Decree No. 16 of 1995 and the Nigerian Investment Promotion Commission Decree No. 17 of 1995, which opened the way for unrestricted foreign portfolio and direct investment. Interest rates were deregulated, and the Technical Committee on Privatisation and Commercialisation Decree of 1995, now the Bureau of Public Enterprises Act, began the second phase of privatisation and commercialisation. These measures were all expected to stimulate the economy, and the study examines how the resulting growth affected the capital market.

1.7 Significance of the Study

Financial experts. The study clarifies how economic growth affects capital market development in Nigeria. Analysts and advisers can use the findings to guide government and other stakeholders toward policies that support growth and, through it, a stronger capital market.

Government and policymakers. The Nigerian capital market has changed considerably as the financial sector has grown in importance, and reforms have aimed at greater efficiency and competitiveness. The findings can inform policies that promote both economic growth and capital market development.

Academic value. Most existing work follows the supply-leading hypothesis, while evidence on growth driving market development is thinner. By testing the demand-following hypothesis, this study adds to the literature and may prompt further research that helps settle the direction of causality.

1.8 Limitations of the Study

Factors other than economic growth may also influence capital market development. Because this study isolates the effect of growth, it does not include control variables for those other factors. It also relies on secondary data, so any reporting errors in the published sources may affect the validity of the results.

REFERENCES

Adeyeye, O. (2015). Does supply-leading hypothesis hold in a developing economy? A Nigerian focus (Proceedings of Economics and Finance Conferences No. 2204823). International Institute of Social and Economic Sciences. https://ideas.repec.org/p/sek/iefpro/2204823.html

Aluko, O. A., Adeyeye, O. P., & Oladele, P. O. (2020). Finance–growth nexus in sub-Saharan Africa revisited: Evidence based on a new composite index. Economic Change and Restructuring, 53(2), 333–355. https://doi.org/10.1007/s10644-019-09253-9

Chow, S. C., Vieito, J. P., & Wong, W.-K. (2019). Do both demand-following and supply-leading theories hold true in developing countries? Physica A: Statistical Mechanics and its Applications, 513, 536–554.

Nigerian Exchange Limited. (2023). NGX weathers global market downturns in 2022, makes strong showing with landmark listings [Market recap and 2023 outlook]. Mondo Visione. https://mondovisione.com/media-and-resources/news/ngx-weathers-global-market-downturns-in-2022-makes-strong-showing-with-landmark-2023125/

Orekoya, S., Afolaby, J., & Akintunde, O. (2021). Bank-based versus stock market-based development in Nigeria: A fully-modified ordinary least squares approach. The Review of Finance and Banking, 13(1), 33–45.

Osamwonyi, I., & Osaseri, G. (2020). A causality study of stock market development and economic growth in Nigeria and BRICS. Acta Universitatis Danubius. Administratio, 12(1). https://dj.univ-danubius.ro/index.php/AUDA/article/view/324